(PUB) Investing 2016

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Funds Grapple With Exposure to Puerto Rico Income Strategist | Elizabeth Foos

muni teams at Fidelity, T. Rowe Price, and Vanguard continue to avoid meaningful concentrations in Puerto Rico debt with their current portfolios. Of Fidelity’s 22 muni funds, six of which carry a Morningstar Analyst Rating of Gold, none had assets invested in the island’s bonds per their most recent portfolios. Several T. Rowe Price and Vanguard funds have some exposure to Puerto Rico, yet the stakes are modest, with most funds holding less than 1% of assets in the island’s debt. OppenheimerFunds and Franklin Templeton Invest- ments remain two of the largest holders of the commonwealth’s debt, with Oppenheimer holding some of the heaviest weightings in its single-state muni funds. Based on the latest portfolio data avail- able, 19 of the 20 Oppenheimer Rochester funds had exposure to Puerto Rico, and 16 had weightings ranging from 10% of assets to nearly 50% . Alloca- tions in the Franklin funds are much smaller. than 0 . 3% of assets to 4 . 0% . The exception was Franklin Double Tax-Free Income, which held nearly 50% of assets in Puerto Rico debt as of the end of March 2016 . The fund experienced net outflows and was reorganized into the firm’s $8 billion Franklin High Yield Tax-Free Income FRHIX as of April 29 , 2016 . According to Morningstar data, Franklin Double Tax-Free Income held less than $145 million in assets at the time of transition and was expected to bring the concentration of Puerto Rico debt in Franklin High Yield Tax-Free Income up from roughly 3% of assets to 3 . 9% . The two Franklin funds in the Morningstar 500 , Franklin Federal Tax-Free Income FKTIX and Franklin High Yield Tax-Free Income, currently list modest weightings of the island’s debt. K Contact Elizabeth Foos at elizabeth.foos@morningstar.com As of March 31 , 2016 , of 32 Franklin muni funds, 24 listed exposure to Puerto Rico bonds ranging from less

Nearly one year since Puerto Rico Governor Alejandro Garcia Padilla stated that the U.S. territory couldn’t pay its $72 billion in debt, little has changed. Although an initial debt payment was made directly after the governor’s 2015 announcement, various agencies have missed debt payments since then. Most recently, the Puerto Rico Government Development Bank, the main fiscal manager for the island’s debt, missed a roughly $400 million debt payment due May 1 . The commonwealth may also miss a $2 billion debt service payment due on July 1 , nearly half of which is secured by Puerto Rico’s general obligation pledge. As we’ve noted before, the commonwealth’s munic- ipal bonds have been held by a number of mutual funds because they pay higher yields and have “triple tax-exempt” benefits. That means the interest earned on Puerto Rico’s bonds is spared from federal, state, and local income taxes, which made them popular investments for some single-state muni funds. And because the names of the funds don’t suggest the presence of such holdings, many investors might not realize how much of this distressed debt is in their portfolios. According to Morningstar’s data, nearly 50% of U.S. open-end muni-bond funds hold some exposure to Puerto Rico bonds, ranging from less than 1% of assets to more than 50% . The balance of these obligations is largely owned by individuals and hedge funds. Many insurance firms and pension funds can’t hold the commonwealth’s debts because of its below-investment-grade-ratings, which the major credit-rating agencies assigned beginning in 2014 . Absent from the list of the island’s investors are some of the largest stewards of capital in the muni market—including most of those with muni-bond funds listed in the Morningstar 500 . For example, the